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Hedge Fund Contagion and Liquidity

Author

Listed:
  • Nicole M. Boyson
  • Christof W. Stahel
  • Rene M. Stulz
Abstract
Using hedge fund indices representing eight different styles, we find strong evidence of contagion within the hedge fund sector: controlling for a number of risk factors, the average probability that a hedge fund style index has extreme poor performance (lower 10% tail) increases from 2% to 21% as the number of other hedge fund style indices with extreme poor performance increases from zero to seven. We investigate how changes in funding and asset liquidity intensify this contagion, and find that the likelihood of contagion is high when prime brokerage firms have poor performance (which would be expected to affect hedge fund funding liquidity adversely) and when stock market liquidity (a proxy for asset liquidity) is low. Finally, we examine whether extreme poor performance in the stock, bond, and currency markets is more likely when contagion in the hedge fund sector is high. We find no evidence that contagion in the hedge fund sector is associated with extreme poor performance in the stock and bond markets, but find significant evidence that performance in the currency market is worse when hedge fund contagion is high, consistent with the effects of an unwinding of carry trades.

Suggested Citation

  • Nicole M. Boyson & Christof W. Stahel & Rene M. Stulz, 2008. "Hedge Fund Contagion and Liquidity," NBER Working Papers 14068, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:14068
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    3. Ewa Dziwok & Marta A. Karaś, 2021. "Systemic Illiquidity Noise-Based Measure—A Solution for Systemic Liquidity Monitoring in Frontier and Emerging Markets," Risks, MDPI, vol. 9(7), pages 1-29, July.
    4. Baur, Dirk G. & Fry, Renée A., 2009. "Multivariate contagion and interdependence," Journal of Asian Economics, Elsevier, vol. 20(4), pages 353-366, September.
    5. Leila Gharbi & Khamoussi Halioui, 2011. "La juste valeur des instruments financiers : Un nouveau canal de contagion ?," Post-Print hal-00650435, HAL.
    6. Her-Jiun Sheu & Chien-Ling Cheng, 2011. "Systemic risk in Taiwan stock market," Journal of Business Economics and Management, Taylor & Francis Journals, vol. 13(5), pages 895-914, August.
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    8. Viral V. Acharya & Stephen Schaefer & Yili Zhang, 2015. "Liquidity Risk and Correlation Risk: A Clinical Study of the General Motors and Ford Downgrade of May 2005," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 5(02), pages 1-51.
    9. Franklin Allen & Ana Babus & Elena Carletti, 2009. "Financial Crises: Theory and Evidence," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 97-116, November.

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    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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